Kinder Morgan’s strategic dividend cut

Kinder Morgan announced that they will be slashing their dividends in 2016, confirming rumors surrounding the company’s future investment decisions. This is just one example of a trend seen in the energy industry as we head into low crude prices for the next several years. Given these economic conditions, a battle is being waged between cutting CAPEX and exploration upstream or finding other ways to keep companies afloat. These decisions are plagued by the question of maintaining investor support and stock prices or funding further development and maintaining investment grade credit rating.

In their announcement on December 8th, Kinder Morgan announced they would be cutting their dividends by almost 75% in 2016 from the current quarterly level of 51 cents per share to 12.5 cents per share. Following a stock price drop from $23.57 on November 30th to $15.72 on December 8th, the outlook is now back to stable. Rich Kinder, executive chairman of the Kinder Morgan board, said in a statement, “This decision was not made lightly, but we believe it is in the best interests of the company [and] other options were uneconomic to our investors in the long run.”

The move to cut dividends is expected to provide $5 billion in DCF per share growth. This method of cost recovery fights low oil prices from a different angle. Rather than simply cutting projects or limiting facilities and operations costs, the company will still be able to provide ample capital to fund necessary projects by delaying returns to investors. While so many projects are being put on the shelf, the added cash flow is allowing companies like Kinder Morgan to fund projects like the Northeast Energy Direct Project (NED). The NED project will help meet increased demand for natural gas and reduce costs across the New England in Pennsylvania, New York, Massachusetts, New Hampshire, and Connecticut by providing a supply path scalable up to 1.2 Bcf/day and market path scalable up to 1.3 Bcf/d.

On the other side of the ball most upstream companies are cutting capital expenditure to just weather the storm. Announcements of Shell’s plan to cut spending by $15 billion over the next three years or ExxonMobil’s statement to reduce spending by 12 percent and more until 2017 show the counter attack. These along with a multitude of similar announcements made in 2015 represent a majority of the reaction to the ongoing energy glut.

New projections show that the almost $250 billion cuts in CAPEX may result in a 19 million barrel reduction in daily crude production. Already limping companies like Energy XXI Ltd, Swift Energy, and countless other smaller independents are feeling the pressure and reducing their CAPEX by more. Head of macro research at Tudor, Pickering, Holt & Co, David Pursell, stated that, “By not sanctioning projects today, you’re putting a hole in production in 2017, 2018 and 2019 — potentially a big hole.” This large hole may be far more detrimental to investors in 2022 than a reduction in their dividend payments.